Investing

New to Investing? Consider These Before Buying Stock

If you have just started your career, aside from the exhilaration that your first pay checks bring you, you should also be thinking about multiplying the money. Of course, the same holds good if you have come into a substantial sum of money unexpectedly as well. Ideally, you want this money to be put to work so that it grows at a fast clip and becomes a nest egg that you can fall back on in the future when you have big expenses or want to fund your retirement.

The minute you talk about multiplying money, it is stocks that come to mind. There are many success stories of people becoming millionaires overnight just by investing in a miracle stock that soared sky high. There are also stories of people having their entire life’s savings wiped out with a single misstep in the stock market. While both are possible in this niche, neither scenario should influence your decision to invest in the stock market. If you want to dabble in stocks, you understandably don’t want to make expensive mistakes. To avoid these, it is necessary for you to keep certain things in mind before you make your first trade.

Gain a complete understanding of your financial goals

To achieve a milestone in any field, the first thing you need to have is a clear visual of the milestone marker. In other words, you should know what you want to achieve in order to get there. It is no different with finances. The very first step to address before you start investing in stock is to define what you wish your investing to do for you, your goal, and your aim in investing in stock. The basic premise is that the investing should let your money grow – that’s a given. However, you need a more concrete goal post, and this may vary from person to person rather dramatically. For example:

  • Goal A: I want to double my money in 10 years.
  • Goal B: I want to get a better rate of return than I am earning right now.
  • Goal C: I am depending on my stocks to build my retirement nest egg.
  • Goal D: I am just dabbling in stocks because the market is soaring right now.
  • Goal E: I need to save enough to build my house in the next 4 years.

Your goal may be different from these as well. That’s not an issue at all, but you need to be clear on what you want because only then will you be able to make the right investing decisions based on the right factors. Making up your financial roadmap is a good plan right now. It will help you not just with getting a clear picture of how much to invest in stocks and how to approach the investing, but also tell you how to handle your finances overall.

Understand the risks and assess your risk tolerance

If you are Warren Buffet with a personal net worth of approximately $68 billion (as of March 2020, following the major stock market drop), you can absorb the loss of a few thousand dollars without even feeling the pinch. But your last name is not Buffet, and you don’t have a fortune that big, so you definitely need to think about what kind of loss you can handle. Or rather, what kind of loss your savings can absorb. That’s where the concept of risk comes in. The truth is that every stock comes with its own risk. The degree of risk varies, but there is no zero-risk stock, even if you are investing in Google. Depending on the degree of risk you can afford, you make an informed decision about which stocks you can invest in and to what extent you can take on exposure in the stock market overall and to individual stocks.

How much risk you can take depends on many factors; again, these will differ from person to person, so you need to figure out your risk appetite based on the unique factors that affect you. Some of the things that may affect your risk appetite:

  • Your age: Someone close to retirement age cannot afford risks at all, whereas someone just starting out in their career can take on significantly higher risk.
  • Your total wealth: This determines how much you can expose yourself to risk. (Buffet can take much more risk than you can.)
  • Your expected expenses: These also play a role here. If you are likely to face huge medical bills in the future, keep your risk low.

There are many other factors that affect risk as well, so think well and define how much risk exposure you can take on.

How much stock do you already own?

This one could be an extension of Point 2 in the sense that your total risk exposure is what you need to keep in mind. The key point to know here is that you may be invested in stocks without even knowing it. How? If you have a savings plan with your employer, say a 401(k), you already have an exposure to stock via this savings route. 401(k)s do invest in safe stocks, so you need not worry about risk here as much, but it helps to find out what the investment allocation is like, how it is done, and what percentage of it is in stocks versus what percentage is in other, less risk avenues.

This does NOT mean that if you have a traditional retirement savings plans like the 401(k) you should not invest in stocks. Stock is still one of the best means to multiply your money quickly, but it pays for you to be aware of the fact that your exposure to the stock market may not be limited to your direct investments here.

Plan to invest for the long term

“If you aren’t thinking about owning a stock for ten years, don’t even think about owning it for ten minutes.” These are the words of the world’s best known and perhaps most successful stock market investor Warren Buffett. Buffet’s success can be attributed quite significantly to his strategy of never investing for a short term in the stock market. In his own words: “Our favorite holding period is forever.” While you need not hold your stock for ever, at the very least, plan to hold them for a period of five years. Any shorter and you simply cannot get the kind of returns that stocks have the potential to offer.

One of the most important reasons why a minimum of five years is recommended is that no stock market downturn lasts that long. It never has and never is likely to either. So if, by an unfortunate turn of events, you invest in stocks and the market crashes, pulling out immediately is not going to help at all. The best thing for you to do is wait it out. By the time the five-year period is done, there is every chance that the market would have recovered, and if you are lucky, it may have bounced back right up where you may be making a profit too. Patience wins the game when you are investing in the stock market.

Learn about dollar cost averaging and apply it

A very popular investment strategy, dollar cost averaging ensures that you do not buy into stock very heavily when it is selling at a price far above its par.  It is quite a straightforward strategy and to explain it in the simplest of terms, what you will be doing here is investing the same amount of money regularly at consistent intervals in the same stock. Keep in mind, you are investing the same amount of money, not buying the same quantity of stock. When the cost is low, you buy more stock; when it is high, you buy less of it. So when you are done acquiring all of the stock that you want to, you have less of stock that comes with a high price tag and more of it with a low-price tag. Your chances of making a profit when you sell are heightened in this way.

The biggest advantage of dollar cost averaging, apart from the risk spread, is that this saves you the trouble of trying predict how the stock is going to move and cuts down the risk involved in making inaccurate predictions in this regard. If the market turns volatile, the impact that your stock acquisition suffers is reduced because you have spread out your purchase over time and price points. A 401(k) follows this strategy to invest your funds in a predetermined selection of investments. You decide how much you want invested at periodic intervals, and the same amount is used irrespective of the market conditions to acquire the assets. By following this same strategy with your own investing approach, you eliminate the risk of making a huge investment that is poorly timed when you look at the price of the stock you are buying.

Diversification is a safety net you cannot ignore

Before you start investing, you need to understand that putting all your eggs in one basket is a very risky move. One broken basket and all your eggs are worthless in one fraction of a second. The situation is quite similar with stocks. Invest your all in one stock, no matter how excellent it seems to be, and you are taking on a massive risk. If that one stock fails, your entire investment is wiped out without a trace. When you focus on just one or very few stocks, you are increasing your risk exposure rather drastically. The solution to this problem is diversification.

Diversification is when you invest in a number of stocks and dilute your overall risk. There are many factors that can affect a company and its stock value – internal issues, external economic factors, industry related problems, government guidelines that impact the company’s fortunes, management changes, etc. As you can see, some factors arise from within the company, some from outside. To diversify with the greatest efficiency, you should have a basket of investments that belong to different industries, that have different management/capital structures. In this way, if one sector or industry stock is in bad straits and your stock belonging to a company from here is spiraling down, another sector may be flourishing, and your stock investment there may make up for this loss. Basically, diversification helps you set off losses and balances out your risk so that your exposure still remains manageable.

Keep track of what is happening

This applies to you in two ways. The first one is for you to keep track of your portfolio. Investing is an ongoing exercise. You can’t drop your cash in stock and then forget about it for five years. You have to keep an eye on what is happening with it, how it is faring, and what the ups and downs are. What about the ‘invest for long term’ rule? Well, you still invest for the long term and don’t indulge in knee jerk selling, but watching your stock gives you a quick and very accurate primer into the vagaries of the marketplace and how they can affect stock. That’s a learning experience. Armed with this knowledge, you are in a position to invest even more smartly in your next stock.

The second way in which you keep track is more comprehensive – stay updated with what is happening in the marketplace in the economy, both your country’s and the global one. This helps you spot good opportunities for investment as soon as they open up. It is by keeping track of the happenings in the industries and economy that the overnight-success-story-investors found the miracle stocks. They knew which ones had the potential to grow big. It is not accidental; it’s quite a well-planned strategy to know how to pick the right stock early on before the market has recognized its potential and the demand has driven up the prices.

Selling the share need not be the endgame

When you start  investing, it is really quite the natural assumption to make that you are buying stock with the intent to sell within a fixed time frame. For most people, stock market investments are a series of buys and sells. However, the interesting thing to know here is that you need not have a sale of the stock as the endgame at all. Sound stocks can yield a very good dividend, and that’s why, if you have enough stock in a very profitable company, your dividends might make a nice recurring income for you.

If you are looking at stock investment as a means of creating a source of steady income in your retirement years, you might just be able to skip the intermediary step of selling the stock and reinvesting in a fixed return instrument that will pay out monthly or quarterly. Instead, you can simply rely on the dividends pay out, in which case, you have a chance to get better earnings when the company performs better since dividends are based on profits. There is risk in this because any company, no matter how sound, is subject to market influences. The point, however, is that you should start stock investing with an open mind about selling it and review the decision to sell when your predetermined time rolls by. Factor in the dividend potential before making the final sell decision.

All brokerages are not the same

Before you can invest in stocks, you need to sign up for an account with a brokerage. A brokerage is a firm that takes your orders to buy or sell and executes those at the stock exchange. You can go over to a physical brokerage and open your account, but far more easily, you can do all of this online as well, along with all of your trades.

Now the important thing for you to know here is that all brokerages are not created equal. You will find that the fee charged by one is far higher than what another one offers. Don’t instantly go for the cheaper one – they may give you a very different set of services, a skeleton set, as compared to the other one. Especially as a novice to stock market investing, you may find some help from the brokerage (you can leverage their expertise in this way) quite valuable. A brokerage that gives you a comprehensive stock market tutorial, help with investing, tips on which stock to buy and when, and inputs on buy/sell decisions may charge you more for the services it provides apart from just handling your trades. So before you sign up with a brokerage, find out what they will give you for the money you pay, and then make a decision on whether it is worthwhile or not.

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